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Pushing further in search
of return: The new private
equity model
As acquisition prices
continue to rise, private
equity funds have to work
harder and longer to secure
a viable return from their
investment. How are the
talent, operational
improvement and exit
strategies adapting to the
new market realities?
Pushing further in search
of return: The new private
equity model
As acquisition prices
continue to rise, private
equity funds have to work
harder and longer to secure
a viable return from their
investment. How are the
talent, operational
improvement and exit
strategies adapting to the
new market realities?
Pushing further in search of return: The new private equity model
Published by PricewaterhouseCoopers Aktiengesellschaft Wirtschaftsprüfungsgesellschaft
By Steve Roberts
August 2015, 40 pages, 23 figures, softcover
All rights reserved. This material may not be reproduced in any form, copied onto microfilm or saved
and edited in any digital medium without the explicit permission of the editor.
This publication is intended to be a resource for our clients, and the information therein was correct
to the best of the authors’ knowledge at the time of publication. Before making any decision or taking
any action, you should consult the sources or contacts listed here. The opinions reflected are those
of the authors. The graphics may contain rounding differences.
© August 2015 PricewaterhouseCoopers Aktiengesellschaft Wirtschaftsprüfungsgesellschaft.
All rights reserved.
In this document, “PwC” refers to PricewaterhouseCoopers Aktiengesellschaft
Wirtschaftsprüfungsgesellschaft, which is a member firm of PricewaterhouseCoopers International
Limited (PwCIL). Each member firm of PwCIL is a separate and independent legal entity.
Preface
Preface
Welcome to Pushing further in search of return: The new private equity model.
Private equity funds have record levels of dry powder and easy access to debt
finance, a picture that harks back to the boom years of 2004–2007.
But this is a very different marketplace. With the supply of quality assets failing
to match demand, buyers are paying premium prices to acquire target companies.
This requires them to generate more value from the asset to meet their return
objectives, which takes longer – holding periods have increased – and demands
more investment in efficiency, channel effectiveness and other forms of operational
improvement.
In this paper, we look at how funding, value generation and exit strategies, which
are the three sides of the new value triangle, are being reshaped by these new
market realities. We also look at the emerging challenges ahead and the likely
drivers for success.
The report draws on a survey of 100 private equity executives from across Europe,
who offer their perspectives on how operational improvement fits into their overall
strategy and equity story, and what they see as the key value drivers in this area. We
would like to thank all of the survey participants for sharing their valuable time and
insight.
We hope that you find the paper useful and informative. If you have any queries
or would like to discuss any of the issues in more detail, please speak to your usual
PwC representative or one of the authors listed on page 36.
Steve Roberts
Partner, Private Equity Leader at PwC
in Germany
“Our firm’s operating models have changed in
the past ten years; we have widened our approach
more with respect to the highly volatile and diverse
market, and we now gauge businesses uniquely
and check all possible options for improvement.”
Managing Director, Germany
Pushing further in search of return: The new private equity model 5
Table of contents
Table of contents
Table of figures.........................................................................................................7
AIntroduction..................................................................................................... 10
B
Debt: How long will the good times last?..........................................................13
COperational improvement: The key to delivering a return................................22
DExit: Making the most of all the available options.............................................29
EConclusion: Pressure for return........................................................................34
Contacts..................................................................................................................36
6 Pushing further in search of return: The new private equity model
Table of figures
Table of figures
Fig. 1European Private Equity Fund Level Return – Allocation IRR drivers...... 11
Fig. 2
How do private equity funds rank the three value drivers?......................12
Fig. 3European Leveraged Finance Issuance.................................................... 14
Fig. 4
European Cov-Lite Volume...................................................................... 14
Fig. 5
Loan Overviews-Leverage Ratios............................................................15
Fig. 6
European Sub-Investment Grade Ratings Distribution............................ 16
Fig. 7Bond Spreads Investment Grade & Subprime Lending/
Sponsored & Non-Sponsored Transactions.............................................. 17
Fig. 8
Credit Margins for Leveraged Loans in Europe Sponsored Deals............. 17
Fig. 9
Private Equity Dry Powder......................................................................18
Fig. 10
General Purpose Diversification for LBOs over Time...............................19
Fig. 11
European Equity Contributions in LBOs..................................................20
Fig. 12
European Institutional Repricing Volume rolling 3 months.....................21
Fig. 13What is your predominant portfolio strategy, which you pursue
in new investments? (Please select only one option)...............................25
Fig. 14
Which levers are most important?...........................................................26
Fig. 15In which form does your company apply the operating model
on portfolio companies? (Please select the most important)....................27
Fig. 16
Holding Period of PE Portfolio Companies in Europe..............................28
Fig. 17
European Buyout Volume: Where Does PE Invest?..................................30
Fig. 18
Number of Secondary Buyout Exits in Europe.........................................30
Fig. 19
Number of Secondary Buyout Exits in Germany......................................31
Fig. 20
Purchase Price Multiples: Sponsor to Sponsor Transactions....................31
Fig. 21
Number of Trade Sale Exits in Europe.....................................................32
Fig. 22
Purchase Price Multiples: Sale to Corporate............................................32
Fig. 23
Number of IPO Exits in Europe................................................................33
Pushing further in search of return: The new private equity model 7
Einleitung: Relevanz gesunden, nachhaltigen Unternehmenswachstums
“The private equity model has fundamentally
changed over the past 10 years.”
The changing dynamics: Interview with Steve
Roberts, Private Equity Leader at PwC Germany
The outlook for private equity
funds remains promising. But
as Steve Roberts explains,
new strategies have been
required to secure expected
return levels.
A lot of people were predicting an
acquisition surge in 2015. Is this
being borne out?
Looking at Germany in particular,
where are the opportunities likely
to emerge from?
Private equity funds certainly have
the finance and the appetite to step
up acquisition levels. Globally, the dry
powder available for investment stood
at a record $1.24 trillion at the end of
March 20151. In Europe, the available
funds have risen beyond $300 billion,
with more than half yet to be invested.
There is a lot of pressure to put this dry
powder to work. But here in Germany
and in Europe as a whole, the limited
number of quality assets coming up for
sale means that actual deal volumes
in 2015 have been steady rather than
surging.
The main focus will continue to be
mid-sized industrial companies. Much
of the mittelstand is of course familyowned. We know that some of the
founders’ grandchildren and great
grandchildren are keen to sell. But not
at any price and not to anyone. With the
German economy continuing to perform
strongly and demand for acquisition
outstripping supply, they know that
they can command premium prices.
They are also mindful of their social
responsibilities and family legacy, and
are therefore only going to sell to buyers
they can trust. It’s therefore important
to approach targets with a strong story
for future investment and growth, as
well as strong financial offers. Funds
may also need to look at a broader
range of opportunities, be this countries
or industries that haven’t previously
been part of the core focus. They may
even need to look at lower quality or
more complex targets, which would
be cheaper but take more time, work
and investment to deliver an eventual
return.
Why are acquisition targets in
such short supply and what is
the impact on prices?
Most corporations have healthy balance
sheets and a lot of money sitting in the
bank. There is therefore less pressure to
divest. With few quality assets coming
up for sale, prices continue to rise.
While average price/earnings ratios of
ten or more might have looked like an
aberration two years ago, they are now
becoming the market norm.
1
Preqin Quarterly Update, Q1 2015.
8 Pushing further in search of return: The new private equity model
The changing dynamics: Interview with Steve Roberts, Private Equity Leader at PwC Germany
What is the impact of higher
acquisition costs on the market?
How is this new market dynamic
influencing exit strategies?
These high and rising multiples are
transforming the value strategies and
equity stories that surround them. There
may be a lot of dry powder around and
leverage is readily available, but more
of these funds are being committed to
acquisition. The more private equity
funds pay, the more they have to do to
secure the right return. Where before
it might have been enough to carve
out and package up the asset for resale
to deliver a return on investment,
buyers now have to look more closely
at opportunities for operational
improvement. Our survey found that
the most important drivers of value are
improved efficiency, sales and channel
effectiveness and working capital
optimisation, though investment in R&D
and entry into new markets also rate
highly.
Certain exit routes are now more
prevalent than at any time since the
financial crisis. While the main route
used to be selling on to another private
equity buyer, the options now include
IPO and corporate sale. The stock
market surge also means that the price/
earnings ratios for exit sales are also
back up to where they were in 2007
and 2008, though these are also the
multiples they are paying for their
next acquisitions, so the bar for value
generation and return keeps rising.
These operational improvement
strategies clearly take time to bear
fruit, which is lengthening the time
funds have to hold companies before
they are ready for resale. Average hold
periods were less than four years in
2008, now they are edging up towards
six years. The make-up of a typical
private equity firm is also changing.
Where the workforce may have been
primarily focused on deals, we’re now
seeing a reasonably even split between
operational and financial specialists.
82%
of the private equity
executives taking part in our survey
say that the potential for operational
improvement is the cornerstone of
their investment decision.
Pushing further in search of return: The new private equity model 9
Introduction
AIntroduction
10 Pushing further in search of return: The new private equity model
Introduction
Following a classic text book approach private equity funds create value thru three
pillars (1) use of leverage (i.e. high debt burden and as little equity as needed), (2)
multiple arbitrage (‘buy cheap/sell high’) and (3) operational improvement (value
generation based on a clear cut investment and value generation strategy – the so
called ‘Alpha’ factor). Historically, leverage and multiple arbitrage have been the
main drivers of success measured by the internal rate of return (IRR). Combined the
two factors have accounted for around 70% of the realised average IRR of 19.61%
(see Figure 1).
Fig. 1European Private Equity Fund Level Return – Allocation IRR drivers
Based on 20 Private Equity Buyout Funds – Investment focus Europe – Funds volume
€300 million–€3 billion – Vintage Years 1995–2000 (i.e. all funds were invested).
Share of avrg. IRR
7%
39%
31%
23%
avrg.
IRR
4.47%
19.61%
PE Alpha 2
Total PE Return
6.01%
7.71%
1.42%
Passive Return
1
2
Leverage
Multiple (industry
Matched PME1)
Unlevered industry matched Public Market Equivalent.
Value add through Private Equity Ownership (e.g. Corporate Governance, Selection
Management Team, Operational Influencers).
Source: London Business School, HEC Paris – sponsored by Pantheon Private Equity & BVCA.
Pushing further in search of return: The new private equity model 11
Introduction
Besides being benchmarked against an IRR level of 20%, going forward private
equity funds face the challenge of how to accomplish a more balanced outcome
amongst the main three IRR drivers. As a result, operational improvement
capabilities have become, and will continue to be, far more important for a private
equity fund’s success. This view is shared by an overwhelming majority of the
private equity executives taking part in our survey (see Figure 2).
Fig. 2
How do private equity funds rank the three value drivers?
34%
45%
21%
41%
39%
20%
16%
46%
Operational improvements
Multiple arbitrage
38%
Financial Leverage
Ranked most important driver
Ranked important driver
Ranked less important driver
Source: Survey of 100 private equity executives carried out by PwC in June 2015.
In this study we have looked at all three success factors and how the dynamics are
evolving.
12 Pushing further in search of return: The new private equity model
Debt: How long will the good times last?
B Debt: How long will the good times last?
Pushing further in search of return: The new private equity model 13
Debt: How long will the good times last?
Funding, including leveraged finance, is reaching record levels, enabling
private equity funds to refinance on highly favourable terms and build up
plenty of ammunition for acquisition. But the easy access to leverage has
to be offset against higher purchase price multiples, which are requiring
funds to commit more of their own equity. And it also remains to be seen
how long these exceptionally favourable debt market conditions would
last once interest rates begin to normalise or the economy heads towards
a renewed downturn.
This is a good time to be seeking finance. The favourable terms are reflected in
the continuing rise in leveraged finance issuance (see Figure 3) and increasing
availability of covenant-lite loans (see Figure 4).
Fig. 3European Leveraged Finance Issuance
in € bn
24.3
22.7
70.1
165.5
2.6
131.3
53.6
44.4
24.5
15.4
2006
2007
2008
Loans
Bonds
2009
35.3
42.3
42.7
2010
2011
36.4
67.4
71.7
78.4
27.1
28.7
2012
20.3
2013
2014
1Q 2015
Source: S&P Capital IQ LCD.
Fig. 4
European Cov-Lite Volume
in € bn
42%
35%
33%
29%
28%
29%
2.09
0.67
9%
3.14
3%
0.12
1.25
0%
0%
1.50
1.27
1Q
2012
2Q
2012
3Q
2012
4Q
2012
1Q
2013
2Q
2013
Domestic
1.03
1.31
19%
Cross-border
40%
37%
1.76
3Q
2013
% of total inst. volume
Source: S&P Capital IQ LCD.
14 Pushing further in search of return: The new private equity model
4Q
2013
4.64
2.57
3.47
2.03
4.04
0.95
1Q
2014
2Q
2014
3Q
2014
4Q
2014
1Q
2015
Debt: How long will the good times last?
Yet, as leverage ratios edge towards pre-crisis levels (see Figure 5), people are
inevitably asking whether we’re heading towards a new bubble. At the other end
of the spectrum, others see today’s easy access to finance as a relatively short-lived
high point, with a lot of the transient new capital likely to switch once interest rates
rise or tougher economic conditions spur a move towards more cautious investment
strategies. So what is driving change in today’s market, how durable is it and what
are the risks?
Fig. 5
Loan Overviews-Leverage Ratios
Leverage Ratios in Europe
5.0x
5.3x
5.6x
6.0x
5.2x
3.8x
2004
2005
2006
2007
2008
2009
4.3x
2010
4.5x
4.4x
2011
2012
4.7x
2013
4.9x
5.0x
2014
1Q 2014
4.8x
1Q 2015
Leverage Ratios in Germany
5.7x
5.0x
5.0x
5.1x
5.0x
4.7x
3.8x
2004
2005
2006
2007
2008
2009
4.0x
2010
5.2x
5.1x
2013
2014
5.4x
5.7x
3.8x
2011
2012
1Q 2014
1Q 2015
Source: S&P Capital IQ LCD.
Pushing further in search of return: The new private equity model 15
Debt: How long will the good times last?
Favoured options
Coming out of the crisis, bond-for-loan structures dominated the lending landscape,
allowing sponsors and some leveraged corporates to use the bond market to replace
ageing, and sometimes tight-to-test, loan financings. The popularity of such
structures and the arrival of new institutional players in the market underline what
many see as a move towards a US-style corporate financing model across Europe.
Over the last 18 months, institutional investors’ search for yield in a market where
demand of high return investment opportunities outstrips supply of promising
assets has encouraged investors to look further afield for openings. As a result,
investors have increased their appetite for riskier assets (see Figure 6).
Fig. 6
European Sub-Investment Grade Ratings Distribution
No. of entities
20
54
24
39
16
14
6
16
30
31
27
27
3
22
34
37
35
29
25
4
17
35
37
36
28
24
12
15
25
32
26
18
30
17
19
38
19
25
31
2005
2006
2007
2008
2009
48
BB+
BB
BB–
B+
16
B
B–
27
36
11
28
38
55
58
29
23
39
2010
141
87
55
65
181
107
88
60
34
31
29
31
41
43
50
51
40
35
41
2011
2012
2013
2014
CCC/CC
Source: S&P.
This has been accelerated by the European Central Bank’s quantitative easing
measures to provide sufficient liquidity to markets. A combination of quantitative
easing and competition among institutional investors to put their funds to work
has resulted in generally favourable terms for borrowers (see Figures 7 and 8) and
encouraged further development in the ‘cov-lite’ European Term Loan B market,
which merges – from a borrower’s point of view – the best from both US Leveraged
Loan and US High Yield Bonds.
16 Pushing further in search of return: The new private equity model
Debt: How long will the good times last?
Fig. 7
Bond Spreads Investment Grade & Subprime Lending/Sponsored & Non-Sponsored Transactions
1,400
1,200
1,000
800
600
487
400
245
200
1
0
Mar. May July Sep. Nov. Jan. Mar. May July Sep. Nov. Jan Mar. May July Sep. Nov. Jan. Mar. May July Sep. Nov. Jan. Mar.
'11 '11 '11 '11 '11 '12 '12 '12 '12 '12 '12 '13 '13 '13 '13 '13 '13 '14 '14 '14 '14 '14 '14 '15 '15
BBB Rated
BB Rated
B Rated
Source: S&P Capital IQ LCD.
Fig. 8
Credit Margins for Leveraged Loans in Europe Sponsored Deals
550
500
446
450
400
350
358
300
Mar. May July Sep. Nov. Jan. Mar. May July Sep. Nov. Jan Mar. May July Sep. Nov. Jan. Mar. May July Sep. Nov. Jan. Mar.
'11 '11 '11 '11 '11 '12 '12 '12 '12 '12 '12 '13 '13 '13 '13 '13 '13 '14 '14 '14 '14 '14 '14 '15 '15
RC/Tla
TLb/TLc
Source: S&P Capital IQ LCD.
Yet it’s still too early to say whether this US-style corporate finance model will
prevail in the long-term in Europe. The new inter-creditor relationships being
forged between bondholders and loan providers have yet to go through a full
cycle. Documentation of new financing structures is only emerging and largely
untested. We would certainly need to see how these developments stand up to
tougher economic conditions before we view this as a permanent shift. Along this
would need to go both a deepening of the European institutional investor base for
speculative credits and a continuous development of the restructuring standards
and insolvency standards across Europe.
Pushing further in search of return: The new private equity model 17
Debt: How long will the good times last?
Where the money goes
As Figure 9 highlights, funds in Europe are sitting on more dry powder than ever
before. However, generally healthy corporate cash reserves and strong balance sheets
means there is less pressure on companies to sell or divest. The resulting paucity of
quality targets coming to market is reflected in the fluctuation in LBO and M&A levels
(see Figure 10). The surge in M&A in Germany in the first quarter of 2015 is especially
noticeable, so is the amount of re-financing and recaps. As obvious sponsors are
clearly trying to harvest and take advantage of the current financial climate.
Fig. 9
Private Equity Dry Powder
in € bn
Dec 2003
75.7
84.7
Dec 2004
85.0
93.4
Dec 2005
129.6
146.0
Dec 2006
183.2
197.0
Dec 2007
241.2
248.8
Dec 2008
246.8
270.7
Dec 2009
242.2
272.6
Dec 2010
211.5
235.1
Dec 2011
228.7
245.3
Dec 2012
195.2
221.4
Dec 2013
245.7
263.8
Dec 2014
236.3
263.1
May 2015
273.9
PE headquartered in Europe
Source: Preqin.
18 Pushing further in search of return: The new private equity model
PE worldwide with focus on Europe
307.5
Debt: How long will the good times last?
Fig. 10 General Purpose Diversification for LBOs over Time
in %
Europe
22.4
5.5
7.1
64.3
2004
26.9
13.1
5.5
11.7
12.4
56.1
2005
68.0
2006
17.6
27.7
9.4
8.8
5.3
67.5
2007
18.1
8.3
2008
86.1
2009
13.8
29.5
32.0
23.1
13.4
71.8
5.3
6.9
2.1
12.9
70.5
2010
56.3
48.1
2012
2013
25.1
21.0
14.1
20.5
33.3
18.6
5.3
32.6
36.3
5.9
42.5
2011
27.6
2014
15.4
48.6
1Q 2014 1Q 2015
Germany
5.7
23.3
28.5
6.9
40.7
6.1
23.9
18.7
11.4
17.2
58.8
38.8
18.5
37.5
9.4
82.9
30.6
27.8
29.0
7.4
8.0
6.2
19.0
63.2
48.0
70.7
40.6
84.0
55.2
33.5
17.5
90.4
72.0
9.1
6.9
44.7
61.6
21.8
2004
LBO
2005
2006
M&A
2007
Refinancing
2008
2009
2010
Recapitalizations
2011
2012
2013
2014
1Q 2014 1Q 2015
Other
Source: S&P Capital IQ LCD.
Pushing further in search of return: The new private equity model 19
Debt: How long will the good times last?
And when the right target does become available, private equity now has to be
prepared to pay premium prices to secure the deal. As Figure 11 highlights, the
equity contribution to LBOs is still much higher as a proportion of the overall
transaction than in 2004–2007. Putting nowadays dry powder to work is hence
more costly despite the renewed availability of leverage. And as the purchase price
multiples that are being paid continue to rise, the equity contribution is much higher
in absolute terms.
Fig. 11 European Equity Contributions in LBOs
2004
33.2%
2005
32.7%
2006
32.9%
2007
32.5%
2008
2009
42.1%
45.4%
46.9%
2010
2011
44.2%
47.7%
2012
2013
42.4%
2014
41.2%
1Q15
41.1%
Source: S&P Capital IQ LCD.
20 Pushing further in search of return: The new private equity model
Debt: How long will the good times last?
The volume of loans being repriced in Europe has been subdued in recent months,
but is now starting to pick up (see Figure 12). The majority of margin reduction
requests in Europe in 2015 have been seen on cross-border deals.
Fig. 12 European Institutional Repricing Volume rolling 3 months
in € bn
4.9
4.4
3.3
3.8
3.5
2.5
2.8
2.5
4.0
3.4
2.7
3.7
3.1 3.0 3.0
3.4
3.3
2.1
2.8
2.0 2.0
1.5
1.4
0.7
0.4
Apr. May Jun. July Aug. Sep. Okt. Nov. Dec. Jan. Feb. Mar. Apr. May Jun. July Aug. Sep. Okt. Nov. Dec. Jan. Feb. Mar. Apr.
'13 '13 '13 '13 '13 '13 '13 '13 '13 '14 '14 '14 '14 '14 '14 '14 '14 '14 '14 '14 '14 '15 '15 '15 '15
Source: S&P Capital IQ LCD.
Prospects ahead
Key developments that are set to shape the price, terms and sustainability of finance
include the higher capital charges under Basel III and the impact of the Alternative
Investment Fund Managers Directive (AIFMD) and Germany’s new capital
investment code (Kapitalanlagegesetzbuch) on ‘alternative’ lending.
Looking ahead, there will eventually be a normalisation of interest rates and
unwinding of monetary stimulus. Moreover, lenders might decide against
financing corporate takeovers which are perceived not to be in line with new
regulatory guidelines. US banks are being encouraged by the Federal Reserve to
avoid financing takeover with leverage of more than six times EBITDA. The new
regulatory intervention could result in more expensive transactions for private
equity firms, as bank lending still plays an important role in financing a deal.
Therefore, while there are bound to be comparisons with 2004–2007, the dynamics
of this market are very different. Finance may be plentiful but even putting it to
work let alone delivering returns is a challenge. We may also be coming to the high
watermark of funding. Indeed, rather than looking for precedents from the past, the
real challenge is how to develop winning strategies in a sector that is being turned
on its head.
Pushing further in search of return: The new private equity model 21
Operational improvement: The key to delivering a return
COperational improvement:
The key to delivering a return
22 Pushing further in search of return: The new private equity model
Operational improvement: The key to delivering a return
Investment in improving efficiency, performance and market reach have
always been important elements of private equity firms’ investment and
return strategies. But as it gets harder to deliver a return on acquired
assets, the operational focus is now central to the private equity business
model. How is this new model changing strategies, investment priorities
and organisational design?
What we mean by operational improvement
Our definition of operational improvement looks beyond the common focus
on efficiency savings towards procurement, working capital management,
commercial optimisation, R&D effectiveness, global footprint design, leaner
back-offices and sales and channel effectiveness, as well as the business
transformations taking place within the ‘Industry 4.0’ world.
At the height of the pre-crisis boom, a private equity firm could expect to carve
out an asset and prepare it for profitable sale relatively quickly. Buoyant economic
conditions meant limited operational uplift would be needed to secure a return.
Cut to 2015 and private equity firms need to make more money to offset the higher
acquisition costs in an economic environment in which returns are exceptionally
hard won. Some have also had to diversify or lower the quality thresholds for the
assets they acquire, presenting them with greater challenges in generating value.
78%
of the private equity
executives taking part in our survey
say that the importance of operational
improvement will increase further
over the next five years.
Pushing further in search of return: The new private equity model 23
Operational improvement: The key to delivering a return
Inevitably, this changing dynamic is reshaping the models within private equity
firms. More than 90% of the 100 private equity executives taking part in our survey
say the way their operating model is being applied has changed over the past ten
years.
“In the past ten years, we have focused completely
on learning and adapting new methodologies and
universally proven strategies for portfolio improvements,
so I would say we have positively changed.”
Managing Director, Germany
Operational value creation is at the forefront of this new model. More than a third
of the executives we spoke to say that it is their predominant portfolio strategy (see
Figure 13). More than 80% of participants say that the potential for operational
improvement and synergies is an important or very important factor in their
investment decision. More than three quarters believe that the contribution of
operational improvement to return on investment has increased and even more
believe that it will grow still further over the next five years. “In the next five years,
our commitment towards the portfolio businesses will increase and we will actively
look at options to improve the processes and the productivity. The competition
is getting more intense and we have to increase our strategies to keep up the
profitability of our portfolio companies,” says a chief operating officer from Sweden.
“Determining feasible exit strategies and making operational improvements in the
business can help in gaining an appreciated value, but the debt crisis in the past has
impacted the appetite of the buyers. Getting a good value is a complex aspect and
so over the years the importance of this has strongly increased,” says a managing
director from Germany.
“Operational improvements tend to have a long
lasting positive impact on the business and also
give investors a positive impression which can be
very encouraging and can attract them to invest
more which is being seen as an advantage”
Managing Partner, Spain
24 Pushing further in search of return: The new private equity model
Operational improvement: The key to delivering a return
Fig. 13What is your predominant portfolio strategy, which you pursue in new
investments? (Please select only one option)
Percentage of Respondents
Multiple Arbitrage
8%
Operational Value Creation
Organic Expansion
(geographic/product)
36%
24%
Buy and Build
32%
Source: Survey of 100 private equity executives carried out by PwC in June 2015.
By contrast, multiple arbitrage appears to have fallen by the wayside, the victim of high
acquisition prices and a more challenging economic environment.
Taking the business forward
While operational improvement is often seen as being synonymous with cost cutting,
the priorities are much broader (see Figure 14). Our survey found that the most
important drivers of value are operational cost reduction, working capital management,
sales and channel effectiveness and working capital optimisation. “Boosting the sales
force effectiveness and commercial optimisation is the most important value driver,
as it accelerates the internal efficiencies and opens up immense value. Sales force
effectiveness and new channels can help the business in entering new customer groups,”
says a managing partner in Germany. Investment in R&D and entry into new markets
also rate highly. “By getting access to firms that have operations in other locations and by
acquiring the majority equity stake in them, we aim at having a global footprint in global
markets especially as we have the finances to initiate and execute these business plans
completely,” said a partner in Denmark.
Pushing further in search of return: The new private equity model 25
Operational improvement: The key to delivering a return
Fig. 14 Which levers are most important?
Operational cost reduction
9
Working capital management
8
Sales and channel effectiveness
7
Leaner backoffice
6
Commercial oeprations
5
Global footprint design
4
Strategic sourcing
3
R&D effectiveness
2
Others
1
Source: Survey of 100 private equity executives carried out by PwC in June 2015.
Some participants go further by arguing that the hard work on operational
efficiency has, or at least should, already have been achieved and therefore deeper
business transformation is needed to generate value. “Over the next five years,
business transformational activities will become the main focus and operational
improvements will already be an important internal business factor. It will become
necessary to not only look at the operational aspects but also external aspects and
opportunities,” says a managing director in Germany.
Shaping the equity story
As investors press for more clarity and insight on how funds are spent, more than
80% of the executives we spoke to believe that the importance of operational
improvement within their equity story has increased. “We check how the
investment fits in and how we will able to manage along with management of other
investments. I feel it is necessary to balance out transactions so that none of the
investments lack attention which could later cause a deficit in expectations,” says a
chief executive from the UK.
26 Pushing further in search of return: The new private equity model
Operational improvement: The key to delivering a return
New demands, new people
So how is this model reshaping private equity firms themselves? One of the most
striking effects of this shift is the impact on the make-up of the typical private
equity firm. Where most of the team would have been made up of financial and
transaction teams, there are now as many operating specialists employed in-house
or through a network – Figure 15 outlines their role in applying the model. “We have
created an operating partners network to widen our approach and understanding
about the target or the portfolio companies’ performances; this has greatly helped
us in achieving our desired results,” says a partner from Germany. “Our industry has
faced enormous pressure to drive operational value from investments and with the
help of operating partners, we are able to get in-depth information on changes that
should be brought about to create more assertiveness within the business. This has
helped us manage our core business investments and portfolio investments tactfully
to achieve value as expected,” says a managing partner in the UK.
Fig. 15In which form does your company apply the operating model on portfolio
companies? (Please select the most important)
Percentage of Respondents
35%
Operating partners network
32%
Target management team
In-house operating partners/
consultants
External consultants
24%
9%
Working alongside operating partners, company management is critical to the
delivery of the operational improvements strategy. They have the technical knowhow that is so vital within Germany’s many specialist engineering companies and
many private equity funds are offering high performance incentives. A strong role
for the existing management and possibly selling family during transition can
also help to assure customers, communities and local authorities about the future
prospects of the company. Breaking the family link can appear like a loss. But
private equity funds can inject investment, management techniques and access to
new markets that the previous owners couldn’t.
Pushing further in search of return: The new private equity model 27
Operational improvement: The key to delivering a return
And as operational improvement becomes more important and, in many cases,
more far-reaching, the time to execute strategies ready for sale is increasing (see
Figure 16).
Fig. 16 Holding Period of PE Portfolio Companies in Europe
in years Ø
Ø 4,7
3.9
2004
4.2
4.3
2005
2006
4.0
2007
3.8
2008
4.2
2009
4.7
2010
5.0
2011
5.3
2012
5.5
5.6
5.5
2013
2014
1Q 2015
Prospects ahead
It is clear that both the breadth and importance of operational improvement
strategies will continue to increase in the coming years. Costs are only one part
of the equation. Companies looking to compete in markets being transformed by
technology won’t survive or thrive without R&D effectiveness, for example. And
this isn’t just the innovative ideas coming from a few creative personnel, but speed
of decision making, speed to market and willingness to embrace change in the
organisation as a whole. The capabilities needed for this operational engineering
are now as important as financial engineering.
28 Pushing further in search of return: The new private equity model
Exit: Making the most of all the available options
DExit: Making the most of all
the available options
Pushing further in search of return: The new private equity model 29
Exit: Making the most of all the available options
Recent surges in stock market prices have enabled private equity firms
to raise sales price expectations and helped to broaden the range of exit
options.
With all the dry powder at private equity funds disposal (Figure 9), they are under
pressure from investors to deploy the funds and deliver high yield exits so they can
raise funds in the future.
The prospects for a successful return have been boosted by the re-emergence of
IPOs and trade sales as an exit option (see Figure 17).
Fig. 17 European Buyout Volume: Where Does PE Invest?
in %
5
7
18
28
27
7
20
27
45
2005
2006
Secondary
38
2007
P2P
22
20
10
4
31
37
2008
2009
Corporate
65
16
37
64
62
43
2010
2011
13
24
5
8
44
4
47
5
13
18
47
30
20
12
4
7
2012
2013
9
38
12
54
49
2014
1Q 2015
Family/Other
Secondary buyouts
With quality assets in short supply, many funds are pleased to be able to put their
dry powder to work through secondary market acquisition. Secondary exits in 2014
exceeded 2007 (see Figure 18), though Germany has been more restrained (see
Figure 19). In turn, sellers are keen to take advantage of sponsor-to-sponsor prices
that are close to pre-crisis levels (see Figure 20).
Fig. 18 Number of Secondary Buyout Exits in Europe
224
202
196
183
154
153
126
125
112
77
48
2004
2005
2006
2007
2008
Source: Preqin.
30 Pushing further in search of return: The new private equity model
2009
48
2010
2011
2012
2013
2014
1Q 2015
Exit: Making the most of all the available options
Fig. 19 Number of Secondary Buyout Exits in Germany
26
21
24
21
20
20
22
15
14
10
4
2004
2005
2006
2007
2008
2009
2
2010
2011
2012
2013
2014
1Q 2015
Source: Preqin.
Fig. 20 Purchase Price Multiples: Sponsor to Sponsor Transactions
10.4x
8.6x
7.0x
6.7x
9.9x
9.7x
8.8x
8.8x
9.4x
9.0x
9.8x
9.0x
7.3x
NA
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
1Q 2015
Source: S&P Capital IQ LCD.
Yet with purchase price multiples at a peak, some funds are focusing on
restructuring and exiting their current portfolio, rather than new acquisition.
Pushing further in search of return: The new private equity model 31
Exit: Making the most of all the available options
Trade sale
Trade sale volumes and prices have bounced back from the crisis lows to provide
renewed opportunities for exit (see Figures 21 and 22).
Fig. 21 Number of Trade Sale Exits in Europe
238
231
236
208
205
224
179
174
152
99
93
2004
2005
2006
2007
2008
2009
79
2010
2011
2012
2013
2014
1Q 2015
Source: Preqin
Fig. 22 Purchase Price Multiples: Sale to Corporate
7.2x
7.2x
7.5x
7.7x
8.2x
9.0x
9.0x
9.9x
8.6x
8.7x
7.4x
9.3x
8.0x
NA
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
1Q 2015
Source: S&P Capital IQ LCD.
It is important to gear operational improvement to the demands of potential trade
buyers as they look to boost growth and position themselves for the future. This
might be enabling them to extend their geographical footprint or acquire new
sources of innovation.
32 Pushing further in search of return: The new private equity model
Exit: Making the most of all the available options
IPO
Many funds looking to exit are running dual-track sale and public placement
strategies. Stock market gains in 2014 have helped to make IPO a potentially
lucrative option. A further attraction of IPO is that it can boost a private equity
firm’s reputation. In 2014, European IPO exits reached a high of 52 compared to
a pre-crisis peak of 45 in 2006 (see Figure 23). As long as stock markets remain
stable in the face of mounting regional and global uncertainty, we’re likely to see
continuing interest in IPO and follow-on offerings.
Fig. 23 Number of IPO Exits in Europe
52
45
37
40
30
27
24
14
12
2004
2005
2006
2007
1
2
2008
2009
3
2010
2011
2012
2013
2014
1Q 2015
Source: Preqin
Recapitalisation
In Europe, recapitalisation as a share of total exits reached a high of 28% in 2014
(see Figure 10). Recapitalisation allows funds to return money to investors by taking
advantage of current financing conditions, with firms extracting around €4.6bn in
2014 and €6.1bn in 2013 through this option. The big question is how well they can
operationally govern portfolio companies whose dividend recapitalisations have
already provided good returns.
Pushing further in search of return: The new private equity model 33
Conclusion: Pressure for return
EConclusion: Pressure for return
34 Pushing further in search of return: The new private equity model
Conclusion: Pressure for return
Private equity funds face a classic quandary. The increase in exit options and prices
should enable them to deliver a highly favourable rate of return. But they also have
to pay more to acquire the assets in the first place.
“There have been constant changes in the regulatory
environment and market dynamics which have made
situations more complex today and increased risks
for private equity businesses. These changes have in
turn pushed us to accept change and have promoted
flexibility in the investment environment.”
CFO Netherlands
Multiple arbitrage simply isn’t an option when asset prices are so high. Funds
therefore see more active operational improvement strategies as the primary way
to square this circle and boost IRRs up to the targets needed to attract further
investment.
But the ability to realise the necessary operational gains remains unproven. With
many portfolio companies having already undergone several rounds of efficiency
savings during the economic downturn, broader and more innovative strategies
are likely to be needed. This operational engineering is likely to focus as much on
R&D effectiveness and technological investment as streamlining operations or
optimising capital, though the latter would need to be in place before anything else
can be achieved.
This changing model demands new strategies and new people. Funds are also likely
to face increased investor and regulatory scrutiny as they navigate through this
new and unfamiliar landscape. There could be as many losers as winners as firms
change tack, reshape their capabilities and vie for renewed investment. What’s
certain is that the typical private equity firm will look very different from the precrisis vintage.
Pushing further in search of return: The new private equity model 35
Contacts
Contacts
Steve Roberts
Private Equity Leader
Tel: +49 69 9585-1950
[email protected]
Daniel Judenhahn
Private Equity Partner: Debt Advice
Tel: +49 69 9585-6976
[email protected]
Alexander Griesmeier
Private Equity Partner: Operational
Improvement
Tel: +49 89 5790-5278
[email protected]
Elena Naydenova
Private Equity Business Development
Manager
Tel: +49 69 9585-6731
[email protected]
André Lerchenmüller
Private Equity Manager
Tel: +49 69 9585-3185
[email protected]
Marcel Reiher
Private Equity Senior Consultant
Tel: +49 69 9585-3979
[email protected]
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36 Pushing further in search of return: The new private equity model
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